Solvency II to increase cost of pension buy-outs to firms by 10%, says PwC

Insurers will be required to hold more capital against any buy-out deals completed after Solvency II comes into force across the EU on 1 January 2016. PwC said that employers and pension scheme trustees planning to complete such a deal should "buy now or pay later", particularly in relation to schemes with substantial numbers of active members.

However, pensions expert Robert Lawrence of Pinsent Masons, the law firm behind Out-Law.com, said that Solvency II was merely one of "a number of issues which impact on an insurer's pricing". He said that companies should not rush to pursue such deals without thoroughly researching the market beforehand.

Buy-outs effectively relieve companies of the investment and longevity risks associated with historical DB pension schemes, which are schemes that promise a set level of pension once a member reaches retirement age regardless of the performance of the underlying investment. Prominent companies including GlaxoSmithKline, Alliance Boots and EMI are among the companies to have entered into this type of deal.

Approximately £13 billion worth of DB scheme liabilities were passed to insurers through buy-out arrangements in 2014; and a further £5bn has been transferred so far this year, according to PwC. However the Solvency II regime, which sets out broader risk management requirements for European insurers and dictates how much capital they must hold in relation to their liabilities, will push up the cost to firms commensurate with the level of risk that they hold.

Jerome Melcer of PwC said that the effect would be most obvious in relation to so-called 'full' buyouts, involving schemes with members yet to retire. Deals which only involve scheme members that have already retired would be less affected by Solvency II, as the increased number of insurers operating in this market had driven down the cost of the deals, he said.

Robert Lawrence of Pinsent Masons said that increased competition between insurers, as well as their own appetite for risk and the attractiveness of the scheme itself, was more likely to affect the cost of buy-outs than the new regulatory regime.

"For example, we've seen new entrants into the market in response to the changes to the individual annuity market as a result of the government's 'Freedom and Choice' agenda, and there may be more new entrants next year which will push down pricing further," he said.

"Going through a buy-out takes time and commitment for trustees, and for schemes' sponsoring employers. An insurer is more likely to want to transact with a scheme if it can see that the trustees have done the groundwork, engaged the BPA [bulk purchase annuity] specialists, prepared the data and secured the support of the sponsoring employer," he said.

Rabbani Choudhury, an insurance law expert at Pinsent Masons, added that it was "too early to say" exactly how prices would be affected by the new regime.

"In fact, it could be that Solvency II delivers cost savings, which helps raise disposable capital and reduces capital requirements for firms," he said. "Some firms that are in advanced stages of Solvency II implementation have stated that the new measures have already strengthened their capabilities and risk management, which in turn has made them more optimistic that in the longer-term Solvency II will help improve their profitability."